Credit spreads measure the risk premium investors demand for lending to corporations instead of the government. They're the bond market's fear gauge — often leading stock market moves by weeks or months.

What Credit Spreads Measure:

Credit Spread = Corporate Bond Yield − Treasury Yield (same maturity)

This spread compensates for:

• Default risk (company might not pay back)
• Liquidity risk (corporate bonds harder to sell)
• General risk appetite (fear vs confidence)

The Two Key Spreads:

Investment Grade (IG) Spread:

• High-quality corporates (Apple, Microsoft bonds)
• Normal: 80-120 bps
• Widening to 200+ bps = growing concern
• Rarely signals crisis alone

High Yield (HY) Spread:

• Junk bonds (riskier companies)
• Normal: 300-450 bps
• Above 500 bps = fear
• Above 800 bps = crisis (2008 saw 2000+ bps, 2020 saw 1100 bps)

Why Credit Leads Stocks:

Bond investors are generally smarter about credit risk than stock investors are about equity risk. When corporate creditworthiness deteriorates:

1. Bond buyers demand higher spreads first
2. Credit tightens → companies struggle to refinance
3. Then earnings fall → stock investors react

Credit spreads typically lead stock market selloffs by weeks. Watch for divergences: If spreads are widening but stocks are stable, stocks will likely catch down.

The Dual Signal:

• Tight spreads: Confidence. Credit flowing. But also potential complacency.
• Wide spreads: Fear. Credit freezing. But also potential opportunity.

Extremes in either direction are signals. Very tight = vulnerable to shock. Very wide = might be capitulation.